Wall Street Misses the Point With Archer Daniels Midland Earnings

By Markets Fool.com

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Wet corn milling facilities in Indiana prepare raw corn to become more valuable foods and chemicals. Source: Jim Hammer/Flickr.

Indecisiveness isn't the most admirable attribute to possess, but Wall Street can't seem to make up its mind when it comes to expectations for agricultural processing company Archer Daniels Midland .

A few years ago, analysts were obsessed with earnings and profits, which had fallen from historical highs despite increasing revenues. Knowing it could do better, the company increased operating efficiency, divested non-essential assets, and invested in high-margin businesses with growth potential. That helped it achieve 22% higher gross profits, 25% higher adjusted operating profits, and 70% higher diluted EPS in 2014 compared to 2013.

Surely that would be enough to appease analysts, right? Nope. Wall Street was quick to point out that the company's $81.2 billion in full-year revenue missed its estimates of $85.3 billion, despite the company's adjusted diluted EPS of $3.20 handily beating the consensus estimate of $3.08 for 2014, according to Thomson Reuters. Of course, delivering more profits on lower sales means Archer Daniels Midland has increased operating efficiency (i.e., higher gross profit margin) -- in this case, faster than Wall Street expected -- which makes for a healthier investment for shareholders. That point was lost on Wall Street.

But before you get worried about headlines or stock movements, let's look at what's really important to investors from Archer Daniels Midland's full-year 2014 earnings.

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Major highlights
By nearly all major measures, 2014 was a great year for Archer Daniels Midland. Operating profits were up sequentially for all major business segments, bolstered by major improvements in bioproducts sales and merchandising and handling services. Meanwhile, record North American corn and soybean harvests boosted volumes for processing centers while strong demand for exports helped maintain healthy margins.

Measure

2014

2013

% Difference

Revenue

$81.2 billion

$89.8 billion

(9.6%)

Gross Profit

$4.77 billion

$3.89 billion

22.6%

Gross Profit Margin

5.9%

4.3%

37%

Adjusted Operating Profit

$3.69 billion

$2.96 billion

24.7%

Adjusted EPS

$3.20

$2.35

36.2%

Source: ADM earnings press release.

The greatly improved performance drove management's decision to increase the quarterly dividend 17%, to $0.28 per share, and target share buybacks in the range of $1.5 billion to $2.0 billion in 2015. In all, dividends and the share repurchase program will return $2.2 billion to $2.7 billion to shareholders this year, compared to $1.8 billion in 2014.

Improved operating efficiency has come at a cost, however. Archer Daniels Midland finished 2014 with just $1.1 billion in cash and cash equivalents -- well below the $3.1 billion balance at the beginning of the year. It's worth noting that much of the spending can be attributed to growth-enabling acquisitions and balance sheet-reinforcing debt payments. As a result, the debt-to-assets ratio continued its steady descension from 25% in 2012 to less than 16% at the end of 2014.

Driving forces
Not all profits are created equally. As mentioned above, the two driving forces for Archer Daniels Midland's big improvement in 2014 operating profits were bioproducts and merchandising and handling. In fact, the two combined to add $640 million in operating profit compared to 2013, which accounted for 87% of the companywide year-over-year improvement.

Bioproducts operating profits of $697 million, good for the company's second-best performing business, were driven by strong ethanol industry metrics. Production costs fell as corn prices nosedived in 2014, while strong demand kept selling prices relatively high. That made it easy for Archer Daniels Midland, the largest ethanol producer in the United States, to crank out ethanol at historically high margins.

Corn kernels being loaded into a truck for delivery to an ethanol facility. Source: KOMUnews/Flickr.

Merchandising and handling operating profits of $511 million ranked third among the company's businesses, but achieved a 171% improvement from 2013. What's amazing is that $263 million, or 51%, of the full-year earnings were achieved in the fourth quarter thanks to strong margins and record volumes of corn and soybeans in the United States. The results will be difficult to match, but improving international operations could provide future earnings growth for the business.

What's ahead in 2015?
Archer Daniels Midland didn't provide 2015 guidance, but it did admit two things. First, the company should continue to rake in profits from processing corn and soybeans in the first quarter, since the same metrics (high margins, strong demand, high volumes) that drove the strong end-of-year performance remain in place. Second, the ethanol market will become more challenging in 2015. Both are areas investors will want to watch in the year and years ahead, but for different reasons.

Archer Daniels Midland generated about one third of its total operating profits in 2014 from converting corn into food products and crushing soybeans into vegetable oils, but their combined performance has been slipping lately. Both businesses saw year-over-year operating profits fall last year, which, when added together, were down nearly 10% from 2013 levels. They fell 2% in 2013 compared to 2012.

A number of factors are contributing to falling operating profits, ranging from increased processing capacity to depressed corn and soybean prices. The company has been able to shift profits elsewhere in the last several years to dilute the effects, but it remains a long-term trend investors will want to keep an eye on.

Meanwhile, developments in the always-volatile ethanol market remain a short-term trend for investors to watch. I recently highlighted why Archer Daniels Midland was likely to struggle to replicate its strong ethanol performance from 2014 in the year ahead, which could deal a devastating blow to full-year earnings. That's especially true considering the bioproducts business contributed over 43% of the company's total improvement in operating profits last year.

US Corn Farm Price Received Chart

US Corn Farm Price Received data by YCharts.

Investors will have to wait and see how management deals with excess stockpiles throughout the industry and increasing corn prices that will drive up production costs to squeeze margins. I find it highly unlikely -- probably impossible -- that the company will match its performance, so it may be a good idea to begin limiting expectations now.

What does it mean for investors?
Overall, Archer Daniels Midland delivered a strong year of operating results in 2014. Sales may have declined compared to 2013, but a big improvement in operating profits means management is executing on its stated goals to increase efficiency throughout the company. Profit margin is a much more important metric to investors than total sales, which seems to be lost on expectation-oriented analysts on Wall Street.

That being said, the year ahead may prove to be challenging. Operating profits could be dragged down solely from weakness in the ethanol industry, which will encounter a fair share of headwinds in 2015. However, Archer Daniels Midland does appear to be on the right track, which could become more apparent once growth-driving acquisitions begin to contribute to the company's top and bottom lines in a more significant way. Until then, shareholders should be able to confidently sit back and watch the execution unfold.

The article Wall Street Misses the Point With Archer Daniels Midland Earnings originally appeared on Fool.com.

Maxx Chatsko has no position in any stocks mentioned. Check out hispersonal portfolio,CAPS page,previous writingfor The Motley Fool, and follow him on Twitter to keep up with developments in the synthetic biology field.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.